Decision-making bias

News

University Clearing

Model agencies collude to fix rates

Decision making bias

Heuristics

Behavioural economist,
Herbert Simon, argued that, when faced with complex decisions, individuals
(using System 1 thinking)
resort to heuristics. Heuristics are decision-making devises that
simplify the process of coming to a reasonable decision when the
‘perfect’ decision is unreachable or unknowable. Heuristics can be seen
as mental shortcuts which enable individuals to make quick decisions
rather than taking too long, or avoid making a decision altogether.

Heuristics are a convenient way of solving the problem of
imperfect
information and limited time in which to make a decision. Examples of
heuristics include using ‘common sense and intuition’ (goods are cheaper
in sales), and using a ‘rule of thumb’ (I only buy if it’s on a special
offer’. However, using common rules of thumb may lead to irrational
decision-making.

For example, it is typical to assume that limited offer
discounted goods are actually cheaper than the average price of the same
good over a period of time when actually they are often not.
Similarly, we commonly assume that ‘best before’ labelling of products
actually means that the good should not be consumed after that date
(which is rarely true). Applying such rules certainly help
simplify day-to-day economic decision making, and without them consumers
would need to allocate far more time to routine decision making than would be justified.
This tends to suggest that
rationality is easily compromised, and is unlikely to be at
the level assumed in traditional economic theory. In short, humans are
only partly rational, and only rational in certain situations.

The role of context - choice architecture

Behavioural economists suggest that decisions are not taken
independently of the context in which the options are presented. How a
particular choice is presented – the ‘choice architecture’ – can have a
significant effect on the choice made. A decision can also be influenced
by the ‘choice architect’. A choice architect is an individual or
organisation that is responsible for organising the context in which
people make decisions. A choice architect may be a parent, teacher,
peer, employer, the media, or a politician. Choices are rarely neutral
and commonly mediated in some way. For example, where a good is
placed on a shelf can affect the likelihood that it will be chosen.

The anchoring and framing heuristics

Behavioural economists argue that individuals may be subject to
anchoring when making simple and complex decisions, which again
provides a constraint on the exercise of rational choice. Anchors create
a bias in favour of a particular decision. For example, what individuals
first encounter, see or hear, become the anchor from which future
decisions are assessed. If, for example, a supermarket displays a 10%
off sign at the entrance to a store, and further into the store ‘up to
25%’ off signs are displayed. The first sign is the anchor, and all
signs are judged by that – so up to 25% off seems a very attractive
proposition indeed.

Individual choices also seem highly sensitive to the process of
framing, which also provides a bias in favour of a particular
decision. How a choice, or how a new piece of information is ‘framed’ is
likely to affect the choice, even when two options have identical
outcomes.

For example, numerous
experiments have shown that when faced with
either winning a given amount of money or losing it, individuals are
rather more averse to the loss. For example, individuals are likely to
fear a loss, of say £50, rather more than they feel they have gained
from being offered £50.

So, an energy company looking to expand its market share may wish to influence a
decision in their favour may stress the loss of not switching to them,
rather than the gain if they did. For example, ‘staying with your current
provider could cost you up to £285’. Of course, inertia may still have a
powerful influence pulling in the other direction, and the existing
supplier can frame their pitch to focus on the cost of leaving them.
People seem much more worried about the costs of exit than the gains
from entry – one reason, perhaps, why few individuals actually switch
energy provider, and that those who do may, in an objective way, be no
better off.

Similarly, an employer may create a contract of employment where the
default working week is ‘zero-hours’. ‘Zero hours’ becomes the frame.
This is likely to mean that being offered 10 hours of work is seen as
relatively attractive as it is more than zero, compared with having
hours reduced from a specific contracted number.

Status quo bias

A status quo bias concerns the tendency for
individuals to continue to make a choice even after the decision has
lost some or all of its benefit. This bias creates a form of inertia,
and can help explain why producers can generate extra revenue by raising
prices for long standing customers. Even despite the popularity of
comparison websites, under controlled
experiments, individuals still
tend to rate their existing insurance provider higher than other providers that
they had never used, even when prices are cheaper.

The availability bias

The availability bias is yet another example of how decisions may be
less than rational and less likely to conform to the predictions of
traditional economic theory. Tradition theory of consumer choice would
tend to suggest that individuals are consistent over time in terms of
the decision to purchase goods or services. However, the availability
bias suggests that we are influenced by recent or significant events
that are the most easy to remember. If memory of the event is easily
available it will be more likely to influence a decision than if it is
difficult to remember, and individuals may over-estimate the
significance of likely of the event occurring in the future.

An
example would be how individuals are more likely to replace their old
central heating boiler following a minor (and, perhaps, easily fixable fault),
even when the repair would see the boiler last for several more years.
They tend to remember the recent fault, rather than the fault-free
period, and over-value the need for a brand new boiler.

Behavioural economists also point to the power of social conformity
on decision making, often citing the classic psychological research
undertaken by Solomon Asch, who found that peer pressure had a
significant influence on the extent to which people lied when
questioned, even when it was ‘obvious’ that they were lying. This,
and other research, suggests that the desire to conform and follow a
particular trend may well override more critical judgments about the
wisdom of ‘joining the crowd’.